Watch out; the yen is rising.

Here's our theory: Hundreds of billions of dollars are caught up in the 'carry trade.' Speculators borrow yen at preposterously low interest rates. They trade the money for other currencies - notably those of English-speaking countries - in order to place the money in higher-yielding investments. They then pocket the difference and think they are geniuses.

The game works beautifully. Nothing goes wrong. That is, until something goes wrong. Then, the speculators get spooked and begin to look for the narrow door that leads out of the trading room. In the best of cases, they exit in an orderly fashion, selling their high-yielding investments and buying back yen so they can repay their loans. Dollars, pounds, and New Zealand dollars go down. Yen and Swiss francs (another low-interest rate currency borrowed for the carry trade) go up.

You will know when the game is over, dear reader, when you see the yen and Swiss franc rising.

Recently, both seem to be moving up. The British pound, on the other hand, took a step down. So far, the movements are so orderly they haven't even been noticed. But watch out...if something goes really wrong, speculators will make a mad dash for the door and many will be crushed.

Last week's mini-crash in China scared a few speculators. U.S. stocks, for example, got hammered down below where they began the year. The stocks and bonds of the money shufflers - Goldman, Morgan Stanley, Merrill Lynch - seem to have topped out. The swap market tells us that their own traders regard their bonds as though they were junk.

The real action may come today, tomorrow...or a year from now. But when it comes, you will be better off holding yen and Swiss francs than dollars or pounds. Sterling looks particularly risky to us - since so much of the hot money of the money shuffling trade has found its way to London.

In the meantime, we note another curious thing...gold is getting clobbered too. How could that be? Remember, there's no magic to the yellow metal. It goes up and down like everything else. Gold is money; it represents purchasing power. The excess liquidity pumped into the world economy by the central banks, the carry traders, and the financial industry represents a kind of inflation of purchasing power, too.

And when inflation increases, so does the price of gold - typically overshooting. A collapse of the liquidity bubble, on the other hand, represents a decrease in purchasing power...a deflation. Gold will not necessarily go up when that happens; it could go down. People will need cash to pay their debts. Cash, for Americans, means dollars.

We don't buy gold because we think it is going up (though we do think it is going up). We buy it because we see the financial world as much riskier than most people think. Inflation...deflation...we expect some kind of 'flation' as a result of all the debt and credit pushed onto the world over the last 15 years.

Remember, a correction should be equal and opposite to the deception that preceded it. This new 'liquidity' - trillions of dollars worth - pretends to be real money. It is not. It has no resources...no real savings behind it. Since it is not real...when the correction comes, it will disappear - along with many of the 'assets' and much of the "wealth" that people today think they have. The good thing about gold is that it will still be there.

*** "Mortgage Crisis Spirals, and Casualties Mount", says the New York Times.

"Now an escalating crisis in the market, which seemed to reach a new crescendo late last week, is threatening a wide band of people. Foremost are the poor and minority homeowners who used easy credit to buy houses that are turning out to be too expensive for them now that mortgage rates are going up, but the pain is also being felt widely throughout the business world.

"Large companies that bought subprime lenders during the boom, like H&R Block and HSBC, are now scrambling to sell them or scale back their exposure. Many investors are also likely to suffer: Wall Street firms made billions in fees, commissions and trading revenue from packaging and selling subprime mortgages to them as bonds."

And now the feds are on the case. New Century - a large California-based subprime lender - is being investigated by securities regulators and federal prosecutors. The G-men saw what happened to Eliot Spitzer's career when he took on a few high-profile corruption cases. The next thing you knew, the man was on Oprah and living in the governor's mansion. They're not going to miss this chance.

Besides, who's going to stand up for the subprime lenders? The three founders of New Century sold shares in 2004, 2005 and 2006 - realizing more than $40 million in profits, according to the Times. Even as late as November of 2006, they were unloading the shares - more than $20 million between August and November alone. They got millions more in dividends, salaries, bonuses and perks. We don't know how much they started with, but recently they were down to just 7% ownership of the firm.

They were getting when the getting was good. At the end of 2004, New Century stock sold for $66. In 2006, you'd still have had to pay more than $40 per share. But if investors liked the stock last year they should be delighted now. Last week, $40 would have bought them nearly four times as many shares.

The best way to make money in the dotcom boom was, of course, not by buying dotcom shares...but by selling them to the public. Likewise, the best way to make money in the housing boom was not by buying a house...or even by buying the shares of a mortgage lender. You would have done much better to start a subprime lending business yourself and sell the shares to the public. The secret was to get out fast...before the market crashed...and before the feds came after you.

*** We wondered last week about the money supply figures for China. Surely, the supply of cash and credit in that go-go country must be going through the roof.

And it has. Money supply (M1) in China is increasing at a 20% rate...it has been going up an incredible 14% rate for the last five years...

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.